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Shares Contract

A typical shares contract would involve a logger cutting the timber and selling the logs. The buyer of the logs would then write one check to the logger and another to the landowner. The proceeds from the sale are split between the landowner and the logger at an agreed upon rate prior to the sale. If timber was sold under a shares contract it is important to determine who actually "owned" the logs at the time they were sold. This will affect whether or not the proceeds you received from the sale will qualify for capital gains treatment. There are two possible scenarios for this type of sale.

First, the logger had a "contract right to cut" the timber. In order to have a "contract right to cut timber" within the meaning of section 631(a) a taxpayer must have a right to sell the timber cut under the contract on his own account or to use such cut timber in his trade or business. Section 631(a) treatment is available for timber that you owned or had a "contract right to cut" for more than one year.

If the logger had a "contract right to cut" then the landowner would qualify for capital gains treatment under section 631(b), pay-as-cut contract, provided there was not a fixed total amount to be received, agreed to in advance of the cutting. If there was a fixed amount agreed to in advance then the sale would be treated as a lump-sum sale.

Second, the logger only has an contract to cut the timber and must either deliver the logs back to the owner or to a buyer specified by the owner, then the logger is only performing a logging service and does not qualify as the "owner" or have a "contract right to cut."

In order to receive capital gains treatment from a shares contract the "owner" must elect and qualify for Section 631(a) treatment. In this instance the land owner would qualify for capital gains treatment under section 631(a) if the timber that was cut was held for more than a year, and was for use in a trade or business.

NOTE: The provisions of section 631(a) were enacted to provide capital gains treatment for the disposal of stumpage by a trade or business. However, there are no restrictions to becoming a trade or business in order to qualify for section 631(a) for occasional sales.

If section 631(a) does not apply then the income from the sale of the logs is subject to the self-employment tax and is taxed at the taxpayers ordinary rate. So if a logger was merely providing a service, the proceeds received by the logger would not qualify for capital gains treatment under section 631(a).

For an overview of how to calculate the proceeds from a section 631(a) transaction and a complete explanation of the definitions and provisions of section 631(a) click here!